Big investors like BlackRock bet against Bill Gross on Fed

A growing number of large investors, including BlackRock and Pioneer Investments, are advising clients to bail out of short- and intermediate-maturity bonds on bets that an accelerating economy will raise questions about the Federal Reserve’s promise to keep rates low. Doubts about the Fed’s benchmark rate could hammer intermediate bonds that trade in part based on expectations of when the Fed will hike its key policy rates, they say.

Bloomberg

Bill Gross

Such calls run counter to the advice of other bond experts like Pimco’s Gross, who advise that moving toward shorter-maturity debt is a beneficial way of alleviating interest rate sensitivity in bond portfolios during a rising-rate environment.

The Federal Reserve has said it will replace its bond-buying stimulus program, due to begin winding down this month, with a promise to keep its target policy rate near zero until well after the unemployment rate drops below 6.5%. But as signs emerge that the economy is picking up steam, the market is beginning to question the length of time before the Fed jacks up rates.

But the risk is that a heated economy prompts the market to discard the Fed’s “lower for longer” mantra, thereby pushing yields sharply higher and prices lower on intermediate maturity bonds, which vary based on when the Fed will hike rates.

“How long is the longer run?” asked Jeffrey Rosenberg, BlackRock’s chief investment strategist for fixed income, in an interview. “This is really impactful to the two-to-five year part of the curve. If you’re hiding out in the short duration strategies, make sure you are in the ultra-short duration strategies.”

BlackRock is advising investors to stay away from bonds with maturities between two and five years, and instead focus either on bonds with maturities that are less than two years away, or longer-term maturities, such as bonds maturing in 10 to 30 years.

Already, we’ve seen seen some signs of angst in the middle of the yield curve. The 3-year note
/quotes/zigman/4868286/delayed3_YEAR traded at a yield of 0.82% Wednesday, up sharply from 0.63% on the day in December that the Fed announced it would wind down its bond-buying program, according to Tradeweb.

Meanwhile, the scarlet letter that was placed on longer-maturity bonds like 10-year notes
/quotes/zigman/4868283/delayed10_YEAR and 30-year bonds
/quotes/zigman/4868063/delayed30_YEAR in 2013 is beginning to fade. The Barclays U.S. Treasury 10-20 Year Index had rare negative returns of 5.8% over the last 12 months, and the U.S. Treasury 20+ Year Index lost 9.9% during the same time-frame.

“We don’t think we’ll see those types of losses in fixed income again. You’ve got higher yields and better carry,” said Michael Temple, director of U.S. credit research at asset-manager Pioneer Investments. “The favored part of the curve is the longer part of the curve.”

Temple recommends a “barbell” approach, which involves buying on the long end and the ultra-short end, but avoiding maturities between three and seven years.

The advice of BlackRock and Pioneer runs counter to the outlook perpetuated by Pimco’s Gross, who just last week said investors should buy maturities between one and five years. While the asset managers remain positive on the shortest part of the curve — securities maturing in less than two years, when the fed funds rate is expected to remain low — the intermediate sector remains a source of contention. Pimco believes the Fed won’t begin to hike its key funds rate until 2016 at the earliest, anchoring those intermediate maturities.

Whether or not the Fed keeps rates low for an extended period of time, the market’s perception is just as important. Jittery traders could perpetuate losses in that intermediate part of the curve if investors dismiss the Fed’s guidance.

“Even if the Fed doesn’t make noise about moving rate hikes closer, investors will begin to interpret everything they say and begin to become fearful of the curve,” said Temple of Pioneer.

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